What is “Appreciation”?
Appreciation refers to the increase in the price or value of an asset over a period of time.
It can be used in different contexts in the field of finance and accounting. In finance, the term appreciation refers to an increase in the price of financial assets such as stocks or real estate.
In accounting, appreciation refers to an upward adjustment made to an asset’s book value in a company’s balance sheet. This is the opposite of depreciation, which is a downward adjustment in an asset’s value over time to account for its usage. Appreciation is also applicable to foreign exchange, where one country’s currency value increases relative to another currency or currencies.
Key Learning Points
- Appreciation of an asset can be due to several reasons, such as increased demand or reduced supply of an asset, or external factors such as inflation or changes in interest rates
- Under IFRS accounting rules, the revaluation model can be used to account for increases in the value of fixed assets. This model aims to revalue fixed assets to their current value.
- To see how much a share price has appreciated over time, the year-on-year and annualized growth rates can be computed.
Appreciation – Reasons
Appreciation of assets can happen for a variety of reasons:
- An increase in demand for an asset e.g. when an economy is growing better than expected, demand for stocks tend to go up due to anticipation of higher corporate earnings
- Lower supply of an asset e.g. companies can buy back shares, which in turn leads to higher share prices
- Inflation e.g. low inflation can result in a rise in stock prices, as investors may speculate that companies will experience a rise in profitability due to higher demand
- Interest rate changes e.g. low interest rates can increase the demand and eventually the prices of real estate assets
Accounting for Appreciation
Under IFRS, companies can account for any increases in the market value of their assets by using the revaluation model, which is used for the periodic revaluation and reporting of long-term assets. This model aims to represent fixed assets with their updated values in the balance sheet of a company and can be used only for assets that have an active market i.e. assets that are regularly bought and sold.
The revaluation model can be used to record appreciation in fixed assets. Under this model, the carrying value of the assets in a company’s financial statement is their fair value (which is usually determined by the market and is the actual value of an asset that is agreed upon by both the buyer and the seller) or revalued amount at the date of revaluation less any accumulated depreciation and impairment.
Revaluations should be done regularly in order to ensure that there is no material difference between the fair value (the market value in reality) and the carrying amount of the asset in the company’s financial statements. However, under US GAAP the revaluation model is not available i.e. companies cannot increase the value of their fixed assets in their financial statements.
The revaluation model can be used only for intangibles whose fair value can be measured through an active market. Typically, active markets are less common for intangible assets such as goodwill. Examples of intangibles with an active market include fishing or taxi licenses and import quotas.
As stated before, various types of assets such as stocks, real estate etc. can appreciate over time. Given below is the 5-year history of the stock price of Apple Inc, as of 2nd March, 20Y1.
Given below is the calculation of the year-on-year and annualized appreciation rate of this stock. What is noteworthy is how much the stock has appreciated over the years.
On a year-on-year basis, this stock appreciated every year and 20Y1 has been the best year (at the time of writing) with an appreciation of 102.0% over the previous year.
On an annualized basis, this stock has grown by 36.6% (i.e. from US$35.92 in 20X7 to US$125.10 in 20Y1). An annualized figure is the average annual growth rate over a given number of years. The annualized growth rate is calculated using the Compound Annual Growth Rate (CAGR) formula.